Understanding third-party logistics (3PL): A complete guide

• 3PLs offer outsourced fulfilment services to business clients, including a warehouse facility and management of everything from inventory to picking, packing and shipping
• 3PLs help businesses achieve cost efficiency via economies of scale, gain instant access to fulfilment infrastructure and a delivery network, as well as scalability to manage seasonal demand
• 3PL management systems go beyond the capabilities of traditional warehouse management software. This includes features to use stock control methods tailored to client order profiles, client portals and streamlined invoicing.
• The key difference between a 3PL and 4PL is the former focuses on the execution of physical fulfilment activities, while the latter strategically manages the supply chain.
• To choose the right 3PL, businesses must consider the provider’s physical assets, capabilities, technology, network of warehouses, pricing and customer service. 

3PL industry definition

Third-party logistics refers to when a business outsources fulfilment activities to an external provider. The provider offers a warehouse facility and manages everything from inventory to picking, packing, shipping and customer service.

How it compares to 1PL, 2PL, 4PL and 5PL

1PL, or first-party logistics, is when a business handles its own fulfilment. When fulfilment is outsourced, the following providers offer:

2PL: Specific fulfilment activities like deliveries or warehousing

4PL: Strategic management of a business’s supply chain, managing fulfilment activities via multiple outsourced providers  

5PL: Management of supply chains for different businesses. 5PLs combine the freight volume of all its clients to secure better rates from third-party providers.

3PL industry evolution

Third-party logistics providers emerged in the 1980s offering basic outsourced functions like transport and public warehousing. Providers evolved to offer these services along with picking, packing and shipping customer orders, as part of an integrated offering.

Now, third-party providers are set up with advanced technology to service multiple clients, often in the same warehouse. Warehouse management systems provide real-time visibility of fulfilment processes, which are enhanced by technology like automated guided robots and AI-driven predictive analytics.

Let’s explore the fulfilment services firms in the 3PL industry provide to clients:  

1. Receiving inventory

   A client’s stock arrives at the provider’s warehouse, where staff check quantity and condition. Received stock is entered into the warehouse management system so inventory levels are updated.

2. Storing inventory

   Stock is moved to shelves, racks or bins depending on its size, weight and shelf life, in addition to whether they’re fast-moving.

3. Order processing

   Via a native or API integration, customer order information is sent from the client’s sales channels or order management system to the provider’s WMS, which then reserves the ordered items and queues the order for fulfilment.

4. Picking and packing

   Warehouse staff retrieve items from storage, often guided by a mobile device. Items are taken to the packing station and placed into packaging featuring the client’s branding, before a shipping label is applied.

5. Shipping and delivery

   Packages are moved to the delivery dock and picked up by a courier. The provider will leverage its delivery network to pick the fastest, most cost-effective option.

6. Tracking and returns management

   The provider’s warehouse management system relays delivery progress to the client and customer. Returned orders are received at the provider’s warehouse, inspected for condition and either placed back in storage or disposed of.

7. Customer service and issue resolution

   The provider handles logistics-related customer queries regarding order progress, including delivery updates, lost or damaged orders and incorrect items received. Other customer service queries typically fall upon the client.

A business can outsource one or several aspects of its order fulfilment activities to a third-party provider, including:

Warehousing and storage

The provider stores the client’s inventory at its warehouse, which could be shared with other clients, taking care of stock receiving and putaway as well as cold chain and hazard material management.

Order fulfilment

Orders received from the client’s sales channels are picked and packed by warehouse staff. The provider can offer the business more efficient processes than those it has in-house, like wave or zone picking in addition to autonomous mobile robots or pick-to-light systems.

Transportation

The provider manages inbound supplier and outbound order deliveries. It leverages its network of couriers to negotiate optimal rates and choose the fastest delivery options.

Inventory management

Via its warehouse management system, the provider maintains real-time visibility and control of inventory levels and movements. It utilises techniques to enhance fulfilment efficiencies; for example, the first-in, first-out method for fast-moving items. The provider also performs cycle counts to ensure accurate inventory visibility.

Value-added services

These can include pre-assembling items into a package before shipping, product customisation, labelling and package design.

Reverse logistics and returns

A provider can receive returned orders and send associated communications to the customer. It will inspect items for damage, before reentering them into storage. The provider can also resend the correct order.  

Let’s look at the software that makes third-party logistics possible.

Warehouse management system (WMS) for third-party providers

A WMS is typically cloud-based software that allows ecommerce businesses and third-party providers to manage warehouse fulfilment activities; from receiving stock and customer orders, to picking, packing and shipping.

A provider uses a WMS to manage warehouse activities for multiple clients. It provides  
real-time visibility and control of inventory as it moves through the warehouse, and optimises storage placement and warehouse space utilisation. A 3PL management system also allows the provider to direct staff on where and how to pick items.

Third-party logistics software capabilities

The best warehouse management systems offer capabilities tailored specifically for third-party logistics. Let’s first cover the core WMS capabilities, followed by those designed for third-party providers.

1. Core capabilities

   • Inventory control: Provides a real-time view of stock levels and movements, from receiving to dispatch
   • Order processing: Integrates with marketplaces and sales channels to automate order validation, stock allocation, order batching and creating shipping labels
   • Warehouse operations: Facilitates use of picking strategies, optimises picking routes, facilitates barcode scanning and streamlines pick list and shipping labels creation
   • Deliveries: Integrates with courier platforms to automatically select the cheapest and fastest delivery options.
     
     

2. Third-party logistics capabilities

   • Client notifications: Automatically sends low stock notifications to ensure levels are replenished
   • Stock control: Facilities methods like first-in, first-out and first-expired, first-out for specialist client stock types like perishable items
   • Client invoicing: You can raise invoices according to rates set for each client for activities including storage, handling, picking, rework, shipping and returns
   • Integrations: Connects to the client’s ERP, inventory management system, sales channels and accounting platforms. Allows for seamless order processing, incoming stock notifications and streamlined invoicing.
   • Client management: You can set up a portal featuring your branding that allows clients to manage product details, view warehouse inventory, check order progress and more.

System integrations

A third-party provider’s warehouse management system relies on integrations with the client’s software systems. This can include API (advanced programming interface) connections to their ERP software or ecommerce platforms.

Some warehouse management systems offer native integrations with marketplaces and courier platforms. Integration is essential for data flow between the WMS and these platforms, including order information, inventory levels and shipping updates. 

Cost efficiency

Outsourcing fulfilment activities allows businesses to use the provider's warehouse and equipment. This means they avoid huge capital investments, paying only for what they use depending on order demand. 

It also allows businesses to tap into the provider’s economies of scale. Because they service many clients, they can negotiate bulk discounts and lower shipping rates.

Scalability and flexibility

Businesses with fluctuating order demand can particularly benefit from outsourcing as they can increase their use of a provider quickly. During peak times, they can easily tap into the provider’s resources, then scale back.

Faster shipping and wider reach

A provider can leverage its network of partners to negotiate the fastest and cheapest delivery options. A business can also use a provider based in another region or one with international shipping partners to expand into distant markets.

3PL industry expertise

Providers focus solely on logistics, so they’re set up to overcome challenges and streamline operations. They use an optimised 3PL warehouse layout, picking strategies and inventory control, achieving efficiencies that reduce costs and delivery times.

Better customer experience

A 3PL warehouse is set up to be more efficient, with technology and facilities likely beyond your business’s budget. Therefore, it can fulfil orders to customers faster and at reduced cost.

Risk reduction

Providers typically have a network of warehouses in different regions that can act as a failover if one is incapacitated. They also invest heavily in security and loss prevention to reduce theft, damage and shrinkage. Providers bear responsibility for compliance with regional regulations, which helps clients save time and avoid the risk of legal complications.

Focus on core business

With fulfilment activities outsourced, a business can dedicate more time and money to driving sales. Cash normally tied up in large capital investments can go towards product development, marketing and a larger sales team.  

Rapid growth

A business may start off with basic warehouse operations capable of fulfilling initial low order volumes. Once volumes outstrip operational capabilities, a business can instantly access a provider’s fulfilment infrastructure, paying only for what they need without a massive cost outlay.

Seasonal demand

During peak demand times, a business can ensure they can service increased orders by tapping into a provider’s infrastructure, and dial down use once demand decreases.

Rising costs

A business can tap into a provider’s economies of scale, which allows them to drive down storage, labour and shipping costs, leading to a lower cost of fulfilment.  

Market expansion

A provider’s network of facilities and delivery partners, which can extend to international realms, can help a business quickly scale into distant regions without setting up new facilities and navigating regional regulations.

Operational distractions

Executing fulfilment activities and logistics can drain valuable time from a business’s leadership. A provider can bear this burden more efficiently and at lower cost, giving a business back time to focus on strategic initiatives.

Contract logistics providers

These providers engage businesses in partnerships for anywhere from three to five years or more. They provide each client a dedicated warehouse with a tailored layout, equipment and staff.

Multi-client warehousing

This is when a provider offers a warehouse that services multiple clients, who share the costs of the lease, utilities, equipment and staff. These facilities have redundant capacity so clients can scale their use up and down as order demand fluctuates.

Ecommerce fulfilment specialists

Focused on direct-to-consumer orders, these providers are set up to efficiently handle single-item orders with a variety of packaging variations and turnaround times.

Omnichannel fulfilment providers

These cater to businesses who sell through multiple channels, like business-to-business and direct-to-consumer.

Let’s look at how these types of outsourced fulfilment providers compare.

Key differences

The fundamental difference is that a third-party provider focuses on the execution of fulfilment activities, while a 4PL strategically manages the supply chain.

A third-party provider offers clients warehouse facilities, equipment and staff. It handles all logistics tasks required to fulfil orders, from receiving stock to the pick and pack of items.

A fourth-party provider doesn't have physical assets like a warehouse. Its main value is in utilising third-party providers to manage the supply chain of a business. A 4PL offers strategic guidance and manages multiple third-party providers on the client’s behalf.

Pros and cons of each

A third-party provider offers the advantage of lower costs and fulfilment execution honed for efficiency. It also gives clients the ability to quickly scale their fulfilment up or down.

On the flip side, these providers don’t provide clients with strategic oversight of their supply chain. Clients are also limited to the capabilities of a single provider. If a business is using multiple providers, complications can arise with integrating their separate systems.

Meanwhile, the advantage of a 4PL is that it provides businesses with a single partner who manages and optimises the entire supply chain, including multiple third-party providers.

Because they aren’t consumed with the physical execution of fulfilment and have a birds-eye view of the client’s supply chain, they can focus on continuously optimising it.

4PLs, however, come with higher costs and a far more complex implementation. They also require businesses to largely give up strategic control of their supply chain.  

When to choose a 3PL third-party logistics provider or a 4PL

It makes sense to choose a third-party provider when a business needs to expand or optimise its physical fulfilment activities, particularly if it needs to do so quickly.

A 4PL is the better choice if a business has a supply chain spanning multiple countries, sales channels, transport modes and third-party providers. It can manage and provide strategic oversight to optimise the entire supply chain.

Loss of control

Handing over responsibility for fulfilment activities means clients lose control over daily logistics operations. Their reputation is in the hands of the provider, and clients may be unable to quickly make changes to their fulfilment activities.

Pricing complexity

Given the pay-as-you-go rates providers charge, fees can fluctuate depending on order volumes, item size and weight, how long items stay in storage or any special handling needs.

3PL industry specialisation limitations

If you need a provider that specialises in cold-chain management or apparel, for instance, they may be smaller outfits. They may have a limited geographic footprint and not be able to increase operations during your peak demand times.

Integration and communication challenges

Integration between the provider’s warehouse management system and the client’s platforms can be complex and prone to error. Without a dedicated account manager, there can also be miscommunications about service level agreements, packaging instructions or exception handling. 

Let’s look at why specific sectors turn to outsourced providers.

Ecommerce and retail

The largest users of third-party providers, these businesses need speed and accuracy to fulfil a high volume of direct-to-consumer orders.

Food and beverage

Food and beverage businesses turn to third-party providers as they need infrastructure like temperature-controlled storage and operations optimised for perishable items, which are often too costly for a single company to maintain.

Healthcare and pharmaceuticals

These businesses outsource fulfilment as they need continuous cold-chain integrity of stock, compliance with strict regulations, secure facilities as well as serialisation and batch-level tracking for instantaneous recalls.

Assess logistics needs

Before evaluating different providers, define your order profile (volume, variety of items, packaging needs) and your inventory profile (SKU count, turnover rate, if they require temperature control or high security storage).

Evaluate capabilities and technology

Assess the provider’s tech stack, including their warehouse management system. Can it facilitate slotting optimisation and efficient picking methods?

Warehouse locations and shipping zones

Learn about the provider’s infrastructure; where its warehouses are and if they‘re located in markets you intend to expand into.

Pricing and scalability

Before signing a contract, get a full breakdown of fixed costs like management fees and variable costs including storage, pick and pack, and shipping fees.

Customer support and communication

Ask providers if they offer a dedicated account manager and what their typical client load is to ensure communications issues can be avoided or quickly resolved.

Performance expectations

Prior to signing a contract, ensure you set out the key performance indicators, like order accuracy rate and on-time shipping rate, to be included in your service level agreement.

Due diligence and site visits

Take a trip out to the provider’s warehouse to assess its layout, organisation and security, as well as how staff operate.